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RMSC: Current Issues in Corporation Governance

The final session of the morning covered Current Issues in Corporation Governance.  Panel members included John Olson, Gibson, Dunn & Crutcher, LLP; and Annita Menogan, Senior Vice President, Red Robin Gourmet Burgers Inc.  The panel was moderated by Cathy Krendl, Krendl Krendl Sachnoff & Way. 

The panel focused on Say on Pay voting and what constitutes a sufficient disclosure to investors.  The panelists suggested looking at case law to see what disclosures have been considered sufficient and what disclosures have been lacking.  Then companies should create disclosures in line with those found to be sufficient.  Another option for companies is to ask the SEC to review the proxy materials and make a determination.  The panel recommended that companies look at peers to see what practices and procedures are used and have the compensation committee carefully document the decision-making process followed when approving compensation. 


RMSC: Regulated Entities Panel Presentation

The third panel focused on Regulated Entities.  Panelists included Carlo di Florio, Director, Office of Compliance Inspections and Examinations, Securities and Exchange Commission; Katherine Addleman, Haynes and Boone LLP; and Mary E. Keefe, Managing Director, Director of Compliance, Nuveen Investments, Inc.  Kevin Goodman, Associate Regional Director – Regulation, Securities and Exchange Commission, moderated the panel. 

The panel focused on the SEC examination process.  Mr. di Florio indicated that the SEC identifies and then focuses on the highest risk issues for examinations.  New SEC procedures mean examinations are now more focused with high-risk issues in mind and the examiners are more prepared at the start.  

Ms. Addleman offered the perspective of outside counsel and pushed Mr. di Florio to change the examination procedure further to have the SEC tell companies when an enforcement person as part of an examination team is simply for training purposes or is for enforcement purposes.  Mr. di Florio explained that this is an unlikely change.  Ms. Addleman suggested that outside counsel speak to many different staff members in a company prior to an examination in order to explain how to talk with government regulators. 

Ms. Keefe shared the company perspective and indicated that the changes Mr. di Florio discussed are working and a recent examination in her organization only took four days.  Ms. Keefe recommended establishing rapport with the examiners from the outset in order to foster communication.  She also stressed the importance of immediately making a plan and identifying employees the examiners might want to speak with during the examination.

The next panel covers Current Issues in Corporation Governance.


RMSC: Perspectives on Defense

The second panel of the conference discussed Perspectives on Defense.  Panelists included Daniel F. Shea, Hogan Lovells LLP, Former Regional Director, Securities and Exchange Commission; Andrew Shoemaker, Shoemaker Ghiselli & Schwartz, LLC; and Linda Thomsen, Davis Polk & Wardell LLP.  The panel was moderated by George Curtis, Gibson, Dunn & Crutcher, LLP, Former Regional Director, Securities and Exchange Commission. 

The panel focused on the value of companies implementing proactive measures, such as whistleblower policies, in order to reduce penalties and liability from an SEC investigation.  Mr. Shea explained that these measures can help and stressed that making modifications to internal controls during an SEC investigation is just as important.  Mr. Shoemaker had a more negative, or perhaps more realistic, view regarding proactive measures and expressed that if the SEC is out for a pound of flesh, then there is not much a company can do. 

The panel discussed several cases to provide defense guidance.  The first case involved the City of Harrisburg where the SEC determined that the City failed to properly disclose required financial information.  The missing information mislead investors dealing in municipal bonds and led to charges of fraud.  The panel explained the importance of implementing policies outlining in detail how and when to update financial information in order to avoid this type of situation. 

The second case, described as the good news case for defense, involved a former employee of Morgan Stanley violating the Federal Corrupt Practices Act (FCPA).  The case is good news for defense because the SEC decided not to pursue charges against Morgan Stanley due to the company having specific policies in place prior to the employee’s actions.  The employee disregarded the company policy so the SEC found that Morgan Stanley was not at fault. 

The final case, described as the bad news case for defense, involved an SEC investigation of Oracle.  The SEC found that no actual bribery under the FCPA occurred, however actions by Oracle created high potential for bribery.  This is scary for defense because it opens the door for penalties even when a violation does not exist.  The panel stressed that this means implementing good internal controls prior to an SEC investigation is crucial. 

The next session focuses on Regulated Entities.


RMSC: SEC Enforcement

The first panel discussed SEC Enforcement issues.  The panel included John Walsh, US Attorney, District of Colorado; Andrew Ceresney, Co-Director, Division of Enforcement, Securities and Exchange Commission; and Julie Lutz, Associate Regional Director, Securities and Exchange Commission.  Regional Director Hoerl moderated the panel. 

Mr. Ceresney began the discussion with a light-hearted joke directed at Hoerl, which gave insight into the high level of camaraderie within the SEC.  He gave an overview of the types of cases the SEC is currently focusing on, such as financial statement fraud, derivative regulations, and JOBS Act rules.  Mr.  Ceresney also gave an overview of the Cooperation Program, launched in January 2010.  The program utilizes tools, such as cooperation agreements, in order to conduct in depth investigations and obtain more facts about each case.  A cooperation agreement is signed by an employee in return for a recommendation to the SEC that the employee receive credit for cooperating in the investigation, with the expectation that any penalties assessed to the employee will be lower than if the employee had not cooperated. 

Mr. Walsh discussed the Residential Mortgage Backed Securities (RMBS) working group.  The RMBS working group consists of the SEC, DOJ, states’ Attorney General offices, and other housing specific agencies such as HUD and FHA.  The group works together to hold accountable those participants who helped bring about the recent financial crisis. 

Ms. Lutz explained parallel proceedings, which generally begin with an SEC investigation, quickly followed by a criminal investigation, with both proceedings continuing at the same time.  The goal is to share knowledge in order to conduct more efficient investigations.  Ms. Lutz indicated that the process has been very effective to date. 

The next session covers Perspectives on Defense.


RMSC: Introductory Remarks by the SEC Regional Director Hoerl

The SEC Regional Director for the Denver Regional Office, Donald Hoerl, began the conference with welcoming remarks.  Director Hoerl’s bio can be found here

Director Hoerl discussed how there are almost daily changes in the securities field with new products and new regulations appearing regularly.  Director Hoerl explained the aim of the conference is to provide relevant information and tools to help attendees navigate this ever-changing field. 

The first panel session focuses on SEC Enforcement.


RTTB & The Rocky Mountain Securities Conference

The Race to the Bottom is proud to attend and cover the 45th Annual Rocky Mountain Securities Conference in Denver.  The Colorado Bar Association and the Securities and Exchange Commission host the event to discuss relevant issues in the field.  The agenda and topics may be found here.  Check back throughout the day for comments on each session.


Meyer v. Greene: The Standard for Loss Causation under §10(b)

In Meyer v. Greene, No. 12-11488, 2013 WL 656500 (11th Cir. Feb. 25, 2013), the Eleventh Circuit Court of Appeals affirmed the dismissal of a class-action securities fraud claim against defendants, St. Joe Company (“St. Joe”) and its officers, concluding that plaintiff, City of Southfield Fire & Police Retirement System (“Southfield”), failed to adequately show loss causation.   

Southfield alleged that St. Joe, a large real estate development company, did not write down the value of, or record impairment charges on, its properties under development even though the land’s carrying value could no longer be recovered due to the deteriorating real estate market.  In doing so, Southfield argued that St. Joe materially overstated the value of its assets in reports made to the SEC. 

To state a securities fraud claim under § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, a plaintiff is required to establish: “(1) a material misrepresentation or omission; (2) scienter – a wrongful state of mind; (3) a connection between the misrepresentation and the purchase or sale of a security; (4) reliance . . . ; (5) economic loss; and (6) loss causation . . . .”  To show loss causation, a plaintiff must prove that the material misrepresentation substantially caused the stock price to decline in value.  Sufficient evidence of loss causation exists when a plaintiff identifies a corrective disclosure, shows a drop in the stock price shortly after the corrective disclosure, and eliminates the possibility of other explanations for the price drop.  However, loss causation is not established if the price of the stock drops due to a change in investor expectations or economic circumstances.  

In general, a corrective disclosure is a release of previously non-public information that exposes a company’s fraud.  Although invoking a “fraud-on-the-market” theory allows plaintiffs a rebuttable presumption of reliance, it inherently limits the sort of information that qualifies as a corrective disclosure.  Under the “fraud-on-the-market” theory, stock prices are a reflection of publicly available information, including misrepresentations, and the release of confirmatory information will not cause the stock price to change.  In turn, to be considered corrective, the disclosure must reveal new information relating to the misrepresentation that was not previously released to the public.

Southfield first asserted that a 2010 presentation by prominent investor David Einhorn constituted a corrective disclosure because the presentation implied that St. Joe’s assets were considerably overvalued.  Although St. Joe’s stock price dropped after Einhorn’s presentation, the court noted that Einhorn’s presentation contained a disclaimer that it was solely based on information from public sources.  Thus, because it failed to reveal any new information, the court concluded that the presentation did not qualify as a corrective disclosure. 

Alternatively, Southfield argued that Einhorn’s presentation qualified as a corrective disclosure because it provided expert analysis of the public information.  While Einhorn’s unfavorable analysis may have changed investor expectations and led to a decline in St. Joe’s stock price, the court reiterated that the mere repackaging of information already known to the public was not sufficient to qualify as a corrective disclosure.  Thus, because the presentation simply revealed the opinions of a prominent investor and did not disclose any fraud by the company, the court again held that the presentation was not a corrective disclosure. 

Southfield also claimed that St. Joe’s announcements regarding two SEC investigations were corrective disclosures.  The court, however, determined that the commencement of an investigation by the SEC alone reveals nothing more than the investigation itself.  Further, although stock prices may naturally decline after an SEC investigation is announced, the decline is the result of a perceived risk and not of fraudulent statements or violations.

Therefore, because none of Southfield’s allegations qualified as corrective disclosures to show loss causation, the Eleventh Circuit Court of Appeals affirmed the district court’s decision to dismiss Southfield’s complaint with prejudice. 

The primary materials for this case may be found on the DU Corporate Governance website.


Scandlon v. Blue Coat Systems: Complaint Dismissed with Leave to Amend

In Scandlon v. Blue Coat Systems, Inc., Robert Scandlon, Jr. brought a class action on behalf of himself and all others similarly situated shareholders (“Plaintiffs”) against Blue Coat Systems, Inc., Brian Nesmith (President and CEO), and Gordon Brooks (CFO, Principal Accounting Officer, and Senior Vice President) (collectively “Defendants”).  No. C 11-4293 RS, 2013 WL 308879 (N.D. Cal. Jan. 25, 2013).  The court found that the claims were factually insufficient under the applicable pleading standards and granted Defendants’ motion to dismiss with leave to amend.  

Plaintiffs claimed that Defendants were liable for fraud under § 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5.  Plaintiffs alleged that Defendants knowingly misled investors and securities analysts about the health of the company by being overly optimistic about sales, growth, and prospects.  Plaintiffs also alleged that Nesmith and Brooks had derivative liability for any of Blue Coat’s violations of § 10(b) under § 20(a) of the Exchange Act.

Section 10(b) prohibits the use deceptive devices in connection with the sale or purchase of securities.  For there to be a violation of Rule 10b-5, a plaintiff must show “(1) a material misrepresentation or omission of fact, (2) scienter, (3) a connection with the purchase or sale of a security, (4) transaction and loss causation, and (5) economic loss.”  To establish scienter, plaintiffs must allege facts that give “rise to a strong inference that the defendant acted with the required state of mind."

The court found that the Plaintiffs’ allegations failed for a number of reasons.  First, the allegations lacked specificity.  Moreover, many of the claims were better characterized as puffery.  The court characterized the claim as an action based upon statements that were “unduly rosy.”  The court, however, reasoned that “[b]usinesses are entitled, however, to synthesize and analyze the available information, and to reach judgments as to how ‘rosy’ things are or are not.”

To evaluate allegations of scienter, a court must look at all of the alleged facts and taking “into account plausible opposing inferences.”  The court found that the Plaintiffs did not adequately plead facts to support an inference of Defendant’s intent to deceive.  The facts also plausibly supported inference that the Defendant incorrectly analyzed the company’s business conditions.  The court also found that since the Plaintiffs did not adequately plead a material misstatement or omission, or allege sufficient facts to show loss causation. 

The court also dismissed the claim under § 20(a) of the Exchange Act because liability was based on the existence of a violation of § 10(b).  Though the Plaintiffs had not alleged adequate facts at that time, the court found it was premature to conclude that proper pleadings were impossible.  As a result, the motion to dismiss was granted with leave to amend the complaint within 30 days.

The primary materials for this case may be found on the DU Corporate Governance website.


Lambrecht v. O’Neal: Double Derivative Actions Doubly Fail Following Merger of Bank of America Corporation and Merrill Lynch and Co.

In Lambrecht v. O’Neal, Nos. 11-1285, 11-1589, 2012 WL 6013440 (2d Cir. Dec. 4, 2012), the Second Circuit Court of Appeals affirmed the dismissal of “two double derivative actions” filed on behalf of Bank of America Corporation (“BofA”) and its wholly owned subsidiary Merrill Lynch & Co. (“Merrill”) following a merger of the two companies on January 1, 2009 (the “Merger”). 

The Merger of Merrill into BofA occurred at the height of the financial crisis.  Plaintiffs S. Leonard Sollins and Nancy Lambrecht owned shares of Merrill.  They brought double derivative suits under Delaware law after they became shareholders of BofA following the Merger.  The district court dismissed Sollins’s claims for failure to demonstrate demand futility and Lambrecht’s claims for failure to show that the BofA board had wrongfully refused to pursue her claims against former directors and officers of Merrill.

Sollins brought two primary claims: (1) that the BofA Board acted with complicity in Merrill’s premerger activities by, among other things, indemnifying Merrill’s directors and not fully disclosing Merrill’s losses to shareholders; and (2) that Merrill’s payment of $3.4 billion in employee bonuses to Merrill’s officers and directors in 2008 amounted to corporate waste.

A plaintiff demonstrates demand futility by establishing a reasonable doubt that the board could have “exercised its independent and disinterested business judgment” in response to a shareholder demand.  In a double derivative suit, a plaintiff must show that the parent company’s board was incapable of making impartial decisions about claims that it owned through its subsidiary.

The Second Circuit found that Sollins’s first set of claims failed to meet the requirement for demand futility.  Sollins alleged that BofA was "complicit" in the wrongdoing by Merrill in the period before the Merger.  The court viewed the allegations as an attempt to “bootstrap his subprime claims against Merrill onto these Merger-related allegations against BofA in an attempt to circumvent the demand requirement.”

His second claim, although considered by the court to be stronger, also failed to meet the demand requirement.  While the BofA board faced the possibility of liability under Section 14(a) and Rule 14a-9 of the Securities Exchange Act of 1934 for not adequately disclosing the 2008 bonuses to shareholders, this did not demonstrate sufficient evidence that the BofA board was unable to pursue claims against Merrill for the bonuses. Although a “strong possibility” existed for BofA to pursue claims against the Merrill board for waste, the possibility did not  “substantially undermin[e]” its ability to defend against the Section 14(a) disclosure allegations.  This failure to demonstrate a “substantial likelihood of director liability” foreclosed Sollins’s ability to demonstrate demand futility.

Plaintiff Lambrecht made three demands upon the BofA Board.  She claimed that the BofA board wrongfully refused to pursue her claims against former directors and officers of Merrill.  The Second Circuit analyzed the refusal under the business judgment rule, which afforded directors the presumption that they acted in good faith, on an informed basis, and in the best interests of the company.  Overcoming this presumption entailed a “considerable burden” that required a showing that the refusal “was made in bad faith or was based on an unreasonable investigation.”  By making demand, Lambrecht conceded the independence of the board.  Moreover, the board tasked the audit committee with investigating the claims.  The Second Circuit found no reason to overturn the lower court’s failure to find bad faith or an unreasonable investigation. 

The primary materials for this case may be found on the DU Corporate Governance website.  


SEC v. Benger: Domestic Purchase or Sale of Unregistered Foreign Securities Required for Section 10(b) Protection 

In SEC v. Benger, No. 09 C 676, 2013 U.S. Dist. LEXIS 21539 (N.D. Ill. Feb. 15, 2013), the court granted defendants’ motion for partial summary judgment based on the definition of “domestic transaction,” finding that the transaction was not protected under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”).

The SEC alleged that defendants perpetrated an international boiler room scheme that defrauded foreign investors of approximately $44 million through the sale of various penny stocks. The SEC grouped the defendants into three categories: Distribution Agents; Escrow Agents; and Integrated Biodiesel Industries, Ltd., the issuer of the stock being sold (“IBI”).

The U.S.-based Distribution Agents entered a contractual agreement with Brazil-based IBI to sell IBI stock to European investors. However, investors were not aware that the agreement provided for a 60% sales commission to the Distribution Agents on each investment. The Distribution Agents allegedly perpetuated the scheme by hiring sales agents based outside the U.S. to employ high-pressure tactics to solicit purchases of IBI stock from European citizens. European investors who decided to purchase IBI stock sent purchase offers and investment funds to U.S.-based Escrow Agents. The Escrow Agents collected the 60% commissions and forwarded the offers and remaining investment funds to IBI’s offices in Brazil. IBI subsequently mailed new shareholder stock certificates to the Escrow Agents. The Escrow Agents then forwarded the stock certificates to the European shareholder. IBI was never registered on a U.S. securities exchange.

Throughout the case, the defendants maintained their entitlement to judgment as a matter of law regarding the sale of one particular stock because the facts showed that the sale of that stock was not a domestic transaction; therefore, the transaction was not protected under Section 10(b) of the Exchange Act.

Section 10(b) protects “only transactions in securities listed on domestic exchanges and domestic transactions in other securities . . . .”  15 USC 78j(b). To determine whether Section 10(b) protects transactions of stock not registered on a U.S. exchange, the court looked to whether the purchase and sale of the stock occurred domestically, as a “domestic transaction.”        

The SEC argued that the IBI transactions fell within the scope of Section 10(b) because the moving defendants traded in the U.S. and a majority of the alleged deceptive activity occurred domestically. This court considered a transaction domestic if the purchase or sale triggered irrevocable liability while within the U.S. or if title transferred within the U.S. Deception in the US standing alone did not trigger application of the statute.

The SEC also contended that IBI became bound within the U.S. when the Escrow Agents accepted the purchase offers within the U.S. The SEC asserted that the Escrow Agents were acting as IBI’s agents and that their acceptance of investor purchase offers within the U.S. made the IBI transactions domestic and binding. The Escrow Agents represented IBI for the limited purpose of forwarding purchase offers to IBI and forwarding the stock certificates for securities purchased to investors.

The court held that the contract was still formed in Brazil because the stock purchase agreements were unambiguously accepted by IBI in that country. The limited representation by the Escrow Agents was insufficient to create any inference of apparent authority that could potentially bind the parties within the U.S.

Accordingly, the court granted the defendants’ motion for partial summary judgment relating to Section 10(b) violations regarding the IBI transactions. We have previously discussed the underlying suit here.

The primary materials for this case may be found on the DU Corporate Governance website.


Corporate Governance and the Courts

We noted years ago that the courts would play a major role in the corporate governance debate and it wasn't likely to be a shareholder friendly one.  Delaware courts, if anything, have become more management friendly than before.  The days when there could be a Van Gorkom or even a Unocal are over.  But the federal courts likewise have a significant role to play in this process. 

Consistent with this concern, the NYT had a story last Sunday about the pro-business nature of the US Supreme Court.  The story is based on a law review article published in the Minnesota Law Review (written by Lee Epstein, William M. Landes, and Judge Posner).  The article is here.  As the article in the NYT noted, this Supreme Court has been "far friendlier to business than those of any court since at least World War II."  Moreover, two justices in particular, Roberts and Alito, were the "most likely to vote in favor of business interests since 1946". 

This can be seen with particular clarity in the securities area.  It seems as if the Supreme Court takes a Rule 10b-5 case almost every term (although some of them arise in the context of class certification).  In at least some of the cases, the overriding philosophy of the decision is not the need to prevent fraud or protection of the securities markets but the desire to limit a private right of action that some on the court clearly do not like.  This was the case in Janus.  

The saving grace with respect to corporate governance is that few cases get to the Supreme Court.  In the federal system, however, plenty get to the DC Circuit, particularly those involving rules adopted by the SEC.  The shareholder access case is an example of a DC Circuit decision that stretched administrative law principles beyond recognition in order to reach the intended outcome. 

The Administration can not do anything about the Supreme Court.  The Administration can, however, do something about the DC Circuit.  The DC Circuit has 11 judges with four openings.  No nominee by the current Administration was confirmed during the first term.  Moreover, the pace is unlikely to pick up.  Currently, there is only one nominee under consideration.  Getting the openings on the DC Circuit filled will likely take some political capital.  But there can be no capital expended until nominees have been submitted. 


Movement on Wall Street Arbitration

Investors have long complained about mandatory arbitration provisions in their brokerage contracts (as well as in many other types of contracts it must be noted).  Their complaints have gained attention, in part due to the high profile dispute brewing between Charles Schwab and FINRA in which FINRA challenged –thus far unsuccessfully—Schwab’s recent expansion of mandatory arbitration clauses in its customer contracts to include class action waivers.  On  April 30th , a  group of 37 federal lawmakers, led by Democratic Senator Al Franken of Minnesota, urged U.S. securities regulators to prohibit Wall Street brokers from forcing customers to sign away their legal right to sue.

"If arbitration offers investors an efficient forum to resolve disputes, as some argue, investors may choose that option - but they should be given the choice," the lawmakers wrote in a letter to Securities and Exchange Commission Chair Mary Jo White. "Ensuring a choice of forum, particularly for small investors, heightens fairness and ultimately enhances participation in our capital markets. We are deeply concerned that the Commission's failure to respond to the dangers posed by widespread forced arbitration will weaken existing investor protections.”

The plea was addressed to the SEC because Dodd-Frank Act authorized the SEC to prohibit or restrict arbitration requirements for both broker-dealers and investment advisers. Specifically, Section 921 of Dodd-Frank authorizes the SEC to “prohibit, or impose conditions or limitations on the use of, agreements that require customers or clients of any broker, dealer, or municipal securities dealer to arbitrate any future dispute between them arising under the Federal securities laws, the rules and regulations hereunder, or the rules of a self-regulatory organization if it finds that such prohibition, imposition of conditions, or limitations are in the public interest and for the protection of investors.’’ Section 921 also authorizes the SEC to ban or regulate pre-dispute arbitration in contracts between “customers or clients of any investment adviser.”  To date, the SEC has not acted on this grant of authority.

At least one commissioner has indicated that it should. Earlier this month, Commissioner Luis Aguilar, called for the SEC to take steps to scale back or limit the use of mandatory arbitration agreements. "We need to support investor choice," Aguilar, a Democrat, said in a speech before the North America Securities Administrators Association, a group of state regulators.  Where Commissioner White stands on the issue cannot be predicted as she was sworn in as SEC chair earlier this month and has not yet publicly discussed many of her policy views.

While the outcome of this most recent plea for SEC action on mandatory arbitration is unknown, changes on other fronts are more certain.   The Financial Industry Regulatory Authority (“FINRA”) Board recently approved a measure that may make it easier for investors to select non-Wall Street affiliated arbitrators if they have a dispute with a securities brokerage.  Under the newly approved measure, all parties would see lists of 10 chair-qualified public arbitrators, 10 public arbitrators and 10 non-public arbitrators. The rules would permit four strikes on each of the public arbitrator lists. However, any party could select an all-public arbitration panel by striking all of the arbitrators on the non-public list. Alternatively, if the parties leave on the non-public list one or more of the same non-public arbitrators, the parties could have a majority public panel—that is two public and one non-public arbitrator. Currently, brokerage customers must agree to resolve all of their future legal disputes with arbitrators previously approved by FINRA. Investor disputes that exceed $100,000 are decided before panel of three FINRA arbitrators. Although customers may affirmatively choose to utilize a panel that includes three public arbitrators, FINRA panels generally default to include one arbitrator with Wall Street experience.

The measure will now be sent to the U.S. Securities and Exchange Commission for approval.

The FINRA change is a small step towards curbing industry power over arbitration.  The SEC could use its authority under Dodd-Frank to make more significant changes.  Whether it will have the will to do so remains to be seen.


Padfield on "Rehabilitating Concession Theory"

I recently posted my latest article, "Rehabilitating Concession Theory,” on SSRN.  Here is the abstract:

In Citizens United v. FEC, a 5-4 majority of the Supreme Court ruled that, “the Government cannot restrict political speech based on the speaker's corporate identity.” The decision remains controversial, with many arguing that the Court effectively overturned over 100 years of precedent. I have previously argued that this decision turned on competing conceptions of the corporation, with the majority adopting a contractarian view while the dissent advanced a state concession view. However, the majority was silent on the issue of corporate theory, and the dissent went so far as to expressly disavow any role for corporate theory at all. At least as far as the dissent is concerned, this avoidance of corporate theory may have been motivated at least in part by the fact that concession theory has been marginalized to the point where anyone advancing it as a serious theory risks mockery at the hands of some of the most esteemed experts in corporate law. For example, one highly-regarded commentator criticized the dissent by saying: “It has been over half-a-century since corporate legal theory, of any political or economic stripe, took the concession theory seriously.” In this Essay I consider whether this marginalization of concession theory is justified. I conclude that the reports of concession theory’s demise have been greatly exaggerated, and that there remains a serious role for the theory in discussions concerning the place of corporations in society. This is important because without a vibrant concession theory we are primarily left with aggregate theory and real entity theory, two theories of the corporation that both defer to private ordering over government regulation.

I plan on highlighting what I think are some of the more interesting parts of the article in the coming weeks.  While I certainly encourage readers to post any comments they may have here, please also email them to me directly at




The Myth of Majority Vote Provisions: Occidental Petroleum and the WSJ

The Journal had an article on Friday noting that, based upon a regulatory filing,"Chairman Ray Irani, one of the most highly paid executives of the last decade, appears to have lost his longtime seat on the oil-and-gas company's board".   The filing in question is a current report on Form 8-K that disclosed a list of directors who received majority support at the Occidental annual meeting.  Mr. Irani's name was  not among the directors listed ("Directors Spencer Abraham, Howard I. Atkins, Stephen I. Chazen, Edward P. Djerejian, John E. Feick, Margaret M. Foran, Carlos M. Gutierrez and Avedick B. Poladian have received a majority of votes cast in favor."). 

The filing does in fact suggest that Mr. Irani did not receive majority support from shareholders.  But it is not correct to suggest at this stage that Mr. Irani has "lost his longtime seat".  In Delaware, a director who receives a plurality but not a majority in fact is elected to the board.  So, despite the absence of majority support, Mr. Irani was, under Delaware law, reelected.

Occidental does have a majority vote policy in place.  This requires directors who do not receive majority support to submit a letter of resignation.  As the policy provides:

  • Pursuant to Occidental’s by-laws, directors are elected by the majority of votes cast with respect to such director, meaning that the number of votes cast “for” a director must exceed the number of votes cast “against” that director. Any director who receives a greater number of votes “against” his or her election than votes “for” in an uncontested election (a “Majority Against Vote”) must tender his or her resignation. Unless accepted earlier by the Board of Directors, such resignation shall become effective on October 31st of the year of the election.

As a result, Mr. Irani will be required to submit a letter of resignation.  It will then be up to the board to determine whether or not to accept the resignation.  For the most part, boards decline to accept these letters of resignation. Directors who do not receive majority support but remain on the board are known as "Zombie Directors." 

So, the WSJ appears to have assumed, as most Americans likely assume, that the failure to obtain a majority of the votes cast results in the defeat of a director.  That would, however, be management unfriendly and, in Delaware, the law does not tack in a management unfriendly direction. 


The SEC, Corporate Governance and the Need for Additional Expertise (Part 3) 

We are discussing the no action letter issued by the SEC in Celgene Corporation. The Staff indicated that a mandatory proposal seeking to separate the positions of chair and CEO could be omitted under Rule 14a-8(i)(1) (not a proper subject for action by shareholders under the laws of the jurisdiction of the company's organization).  The Staff further indicated that the proposal could not be omitted if the submitting shareholder changed it from mandatory to precatory.

This is not the only example of suspect analysis. In USA Technologies, Inc. (March 27, 2013), the staff permitted the exclusion of a proposal that requested that the board adopt a policy that would rquire the chair of the board to be an independent director. The company, however, had a bylaw that required that the two positions be combined.  Rather than simply request that the shareholder change the word "policy" to "bylaw," the Staff agreed that the proposal could be excluded as "vague and indefinite."   Thus, despite the obvious intent of the proposal (to engineer a referendum on the company's policy of combining the two positions) and the simple fix, shareholders were denied the right to speak to an important governance issue. 

The effect of the analysis in USA Technologies is to shut off a debate.  The effect of the analysis in Celgene Corporation is more severe.  It prevents shareholders from submitting binding proposals that may be permitted under state law.  Moreover, by refusing to allow for a mandatory proposal, the Staff effectively prevents the matter from ever being resolved.  To the extent that the proposal is adopted, the precatory nature means that the company can ignore it.  As a result, there will be no need to test the legality of the provision in the Delaware courts.

The approach of the Staff also does not take into account the imbalance of resources that can occur in the shareholder proposal area.  In this case, the company obtained advice from outside counsel.  A separate opinion was authored by Delaware counsel.  No letters from counsel appear to have been submitted by the shareholder making the proposal.  It may be that the shareholder affirmatively chose not to do so.  It may also be the case that the shareholder lacked the resources to obtain comparable advice/opinions.  Had the shareholder submitted countervailing opinions, perhaps the outcome would have been different. 

Where, in non-governance cases, the the Staff confronts an administrative process weighted in favor of one side, it can use its own expertise to help equalize matters.  This is particularly true with issues that arise under the federal securities laws.  The matter in this case, however, was not a securities issue.  Although arising under Rule 14a-8, it fundamentally turned on state law.  The Staff of the Commission has no expertise on matters of state law. 

This suggests two possible solutions.  One would be to rewrite Rule 14a-8 to reduce the Staff's role in approving shareholder proposals.  That was suggested in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.  The result would be allowing more proposals to be included and allow companies/shareholders to test their legality in state court. 

Alternatively (and more realistically), the Commission should acquire the requisite expertise.  It is time for the SEC to create a position (perhaps a fellow from academia) to provide the necessary corporate governance expertise. 


The SEC, Corporate Governance and the Need for Additional Expertise (Part 2)

We are discussing the staff's recent position in Celgene Corporation (March 27, 2013), a no action letter addressing a shareholder proposal seeking to require the separation of the positions of CEO and chair.  Specifically, the proposal stated:

  • Celgene Corporation's Chair of the Board shall be a director who is not concurrently an executive officer of the company.  Celgene's Corporate Governance Guidelines and any other similarly relevant governing documents shall be amended accordingly.  Such amendments are to be implemented as soon as practicable, but in no event at a time or in a manner that would violate any contract or any federal, state or foreign law.

In seeking to omit the proposal, the company, among other things, argued that it was not an appropriate subject for shareholder action.  The company took the position that the proposal would "usurp the exclusive authority of the Board".  According to the company:

  • The Staff has noted that a board of directors may be considered to have exclusive authority in corporate matters, absent a specific provision to the contrary in the corporation code of the state in which it is incorporated, the issuer's charter or its bylaws. Nothing in the DGCL, Celgene's Certificate of Incorporation or its Bylaws restricts the authority of the Board in respect of the appointment of a chairman or corporate officers.  Rather, Section 142(a) of the DGCL provides that "officers shall be chosen in such manner and shall hold their officers for such terms as are prescribed by the bylaws or determined by the board of directors" and Section 2.3 and 3.1 of the Bylaws provide, respectively, that the Chairman and executive officers of Celgene are to be elected by the Board.  Consistent with that regime, Section 2.3 and 4.2 of the Bylaws give the Board exclusively the power to remove the Chairman and officers, respectively.

The Staff agreed that there appeared "to be some basis" for the view that the proposal was "an improper subject for shareholder action" but that the concern could be remedied by making the proposal "a recommendation or request to the board of directors." 

The Staff's position is tantamount to a finding that mandatory provisions seeking separation of the positions of CEO and chair are always improper under Rule 14a-8(i)(1).  The company's reasoning would for the most part apply to most if not all companies incorporated in Delaware.  Companies are unlikely to provide explicit authority to shareholders to make unilateral determinations with respect to the board of directors.  

Were the law in Delaware absolutely clear, the outcome would be beyond the control of the SEC.  But in fact the law is not so clear.  For one thing, even the company's letter notes that officers can be appointed in the bylaws.  Shareholders have the authority to adopt bylaws.  See 8 Del. C. 109 (a) ("After a corporation has received any payment for any of its stock, the power to adopt, amend or repeal bylaws shall be in the stockholders entitled to vote").

Second, Delaware has stated that process oriented bylaws involving the board of directors are permissible subjects for shareholder action.  See CA, Inc. v. AFSCME Emples. Pension Plan, 953 A.2d 227 (Del. 2008).  While Delaware has not ruled on a proposal calling for the separation of chair and CEO, the provision may be consistent with state law, even when phrased in mandatory terms.

The proposal sought any necessary changes to guidelines and other relevant governing documents that were needed to implement the requirement.  Rather than force a shareholder to change the proposal to a recommendation, the staff could have interpreted the language to require conforming changes to the bylaws.  Alternatively, the Staff could have asked the submitting shareholder to phrase the proposal as an amendment to the bylaws.  Either approach would leave the mandatory/precatory nature of the proposal up to submitting shareholders.

Allowing the matter to go forward would not prevent the company from contesting the requirement.  To the extent that the provision passed, the company could argue that the matter was invalid under Delaware law and litigate the issue in state court.  The position of the Staff, however, ensures that a mandatory provision will never be adopted (at least under Rule 14a-8) and, therefore, will never be tested in state court.  The position of the Staff also effectively bars shareholders from every requiring a separation of the two positions, even though they may well have the authority to do so under state law.  


The SEC, Corporate Governance and the Need for Additional Expertise (Part 1)

The difficulties incurred by the SEC in the rulemaking area has resulted in the Agency creating a new office and acquiring additional economic expertise. The Division of Risk, Strategy, and Financial Innovation Overview was set up in 2009 in order "to integrate financial economics and rigorous data analytics into the core mission of the SEC." 

The example of acquiring expertise from outside the Agency needs to be replicated in the area of corporate governance.  The SEC is increasingly finding itself thrown into the middle of corporate governance disputes.  They range from disclosure in the area of corporate social responsibility (conflict minerals, for example), the facilitation of shareholder nominees (access), and increased transparency in the area of political expenditures.

But all of these areas are relatively new.  It turns out that the greatest direct involvement in the corporate governance process is in a longstanding area of regulation:  Rule 14a-8.  The SEC is the gatekeeper that controls entry by shareholders into the proxy statement.  The Rule provides a number of relatively objective rules that the staff administers effectively.  Yet parts of the rule are not areas where the staff has particular expertise.  This is particularly true with those involving state law. 

The application of the "ordinary business" exception to Rule 14a-8 has traditionally been a highly problematic area.  The staff is called upon to decide whether the substance of a particural proposal improperly intrudes into the state assigned functions of the board of directors.  In other words, the staff is trying to determine the parameters of state authority.  For more on this, see Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.

Similarly, a provision may be omitted if it is "not a proper subject for action by shareholders under the laws of the jurisdiction of the company's organization".  See Rule 14a-8(i)(1).  This is another area where the SEC has no natural expertise. 

In these circumstances, there has been at tendency by the staff to duck the issue through the use of precatory proposals.  Indeed, the staff (and Rule 14a-8) pushes shareholders in this direction.  The Note to Rule 14a-8(i)(1) stated that "some proposals are not considered proper under state law if they would be binding on the company if approved by shareholders."  As a result, "most proposals that are cast as recommendations or requests that the board of directors take specified action are proper under state law."

There are many strategic reasons why precatory proposals may be useful.  Shareholders may be more willing to support an advisory proposal and, concomitantly, less likely to do so for binding proposals.  Yet the language attached to subsection (i)(1) suggests that the approach will often be the price paid for admission to the proxy statement.  In other words, its not strategic but, for the most part, required. 

The problem, of course, is that precatory proposals can be ignored.  In some cases, actually binding the hands of the company is a better approach and more consonant with the wishes of shareholders.  Yet they may not be able to include a proposal that is binding under the reigning standard. 

The difficulties in this area can be seen clearly in the no action letter issued to Celgene Corporation (March 27, 2013).  The proposal sought shareholder approval of a resolution that would require the separation of chairman and CEO.  The SEC staff agreed that the matter was an improper subject for shareholder action under state law.  Nonetheless, the defect could be cured "if the proposal were recast as a recommendation or request to the board of directors."  In other words, an precatory resolution would pass muster, a binding one would not.

We will discuss this approach in the next post.


One Court Bows out of Resource Extractive Industry Rules Challenge

An earlier post discussed the resource extractive industries rules promulgated by the SEC pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act.  In brief, the rules require resource extraction issuers—defined as companies that are listed on a U.S. stock exchange and engage in the commercial development of oil, natural gas, or minerals--to disclose any “payment” to a foreign government or the United States government made to further the commercial development of oil, natural gas, or minerals.  Covered issuers must submit an “annual report” to the SEC disclosing the type and total amount of . . . payments made for each project and the type and total amount of such payments made to each government.

The annual report must be submitted in an interactive data format that includes “electronic tags” identifying, among other things, “the total amounts of the payments,” “the currency used to make the payments,” and “the government that received the payments.” Further, to the extent practicable, the SEC must make available online, to the public, a compilation of the information required to be submitted. In the cost-benefit analysis it did of the final rules, the SEC calculated that the total initial compliance costs for all resource extractive issuers would be approximately $1 billion and that the ongoing compliance costs would likely be between $200 million and $400 million.

To no one’s great surprise, industry groups quickly filed legal challenges to the rules claiming, among other things, that the SEC failed to weigh the costs and benefits of the rule and its effect on capital formation, competition and efficiency and that the rules would violate the industry's First Amendment rights.  Of note for this post is that “out of an abundance of caution,” petitioners filed two actions; one in the US Court of Appeals for the District of Columbia and one in the US District Court for the District of Columbia.  The District Court action was stayed pending a decision from the Court of Appeals.

On April 25th the Appeals Court declined to rule on petitioner’s legal challenge, instead dismissing the petition for lack of jurisdiction, an issue that had been raised only by OxFam International, an intervener in the case.  The unanimous decision by the three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit now means that the District Court will hear the case.  Prior to the ruling of the Court of Appeals, petitioners vehemently argued that forcing the suit to proceed first in district court would be inefficient because it requires no fact-finding and would simply delay the ultimate resolution of the case.   

The Court of Appeals rejected this contention, finding that Congress “knew it would be sending some cases to the district court that require no fact-finding. Indeed, under the Administrative Procedure Act, many challenges to agency regulations are heard first in the district court and then reviewed de novo by this court. To be sure, this may not be the most efficient way to resolve such cases, and we certainly understand petitioners’ desire to have these important issues addressed expeditiously. But it is Congress’s job, not ours, to determine “ ‘the court in which judicial review of agency decisions may occur.’ ”

Proponents of the resource extractive industries rules were quick to trumpet the ruling as a victory for their side.  “The court’s decision to dismiss the case on jurisdictional grounds is a victory for transparency supporters, investors and citizens in resource-rich countries,” said Ian Gary, senior policy manager of Oxfam America’s oil, gas and mining program.

Others noted that the decision is the latest in a series of victories for advocates of greater transparency in the financial arrangements between oil, gas, and mining companies and the governments of the countries where they operate. For example, the SEC denied the petitioners’ request to suspend the transparency regulations pending the outcome of the litigation, ruling that companies had provided only speculative evidence that they would suffer significant or irreparable harm. Further, the Board of the voluntary Extractive Industries Transparency Initiative has announced that it will strengthen its disclosure guidelines based in part on the SEC’s mandatory disclosure rules. Additionally, the European Union agreed to adopt rules for all of Europe that go even further than Cardin-Lugar (the resource extractive industries provision) and two largest Canadian mining associations announced that they would work with transparency advocates to develop mandatory rules for Canada that would parallel the U.S. scheme.

While the Court of Appeals decision certainly marked a defeat for Eugene Scalia, counsel for the petitioners, it is not the sweeping victory claimed by OxFam and others.  There was no discussion of the merits, merely a discussion of jurisdictional matters. The upshot of the decision is that after six months of litigation, petitioners must start over, in the district court.  With the legal challenge now moving to a lower court, the resolution of the case could be drawn out for an indeterminate length of time.  That will leave covered issuers in a continual state of uncertainty as they are required to begin complying with the rules by early next year—unless they are overturned by some court.


The Future of Legal Scholarship: The JOBS Act, 90 Denv. U. L. Rev. Online 63

Legal scholarship has been heavily criticized in recent years.  Among other things, hard copy scholarship has been criticized for its length, inaccessability, and tardiness in arriving on the scene.  The latter concern means that traditional legal scholarship is often published too late in the debate to have much impact on regulatory and policy outcomes.

Law reviews have responded by setting up online companions.  They are designed to publish shorter and more topical pieces on a much quicker time frame.  As I discussed in Essay: Law Faculty Blogs and Disruptive Innovation, this approach is easier said than done.  Online companions struggle for strong content.  Moreover, they require a beefed up law review staff that will cite check pieces as they arrive.  Given these difficulties, it is not unusual for online companions to focus on comments on hard copy articles. 

One way to provide valuable and topical content is to engage in a collaboration between faculty, students, and the law review.  This recently occured at the University of Denver Sturm College of Law. 

In the fall of 2012, I taught a class that required students to write a 15 or so page paper on an aspect of the JOBS Act, legislation adopted by Congress in 2012 that sought to reform the capital raising process.  Each addressed a different aspect of the JOBS Act.  The Law Review at the University of Denver agreed to publish the papers as an online issue but reserved the right to reject any and all papers that did not meet their standards for quality.      

Students in the class worked extremely hard on these papers (some submitting more than 10 drafts).  They all examined statutory language and applicable legislative history.  The final papers were for the most part topical, useful, and short.  They were written in a highly accessible prose.  At the same time, they were thorough, with each having approximately 50 to 90 footnotes.

Eight papers have now been published by the DU Law Review as part of an entire online issue. The JOBS Act, 90 Denv. U. L. Rev. Online.  The papers are listed below. 

The issue required a major commitment of faculty time.  In the end, however, students obtained a useful publication in an area of law that interested them.  The Law Review obtained substantive articles that are likely to be read by pratitioners and regulators (perhaps even a few academics).  With the SEC in the process of writing rules for the JOBS Act, the papers even have the potential to play a role in regulatory regime ultimately put in place.   

Online scholarship is not designed to replace hard copy articles but is an alternative forum with particilar advantages.  It provides an effective mechanism for immediate participation in an ongoing debate and an opportunity to influence outcomes, whether regulatory, legislative, or judicial.  The JOBS Act issue represents an example of how this might occur.


The JOBS Act Title V: Raising the Threshold for Registration
Susan Beblavi

The JOBS Act: Exempting Internet Portals from the Definition of Broker-Dealer
Samuel Hagreen

The JOBS Act: Does the Income Cap Really Protect Investors?
Lina Jasinskaite

The JOBS Act Title I: The “On-Ramp” to IPOs for Emerging Growth Companies
Will McAllister

Regulation A+, the JOBS Act, and Public Offering Lite
David Rodman

Crowdfunding and State Level Securities Fraud Enforcement under the JOBS Act
Michael W. Shumate

The JOBS Act and the Elimination of the Ban on General Solicitations
Erica Siepman

Crowdfunding and Using Net Worth to Determine Investment Limits
Lindsay Anderson Smith


The Puffery Defense As Theatre of the Absurd

This past week the Wall Street Journal reported that:

Standard & Poor's Ratings Services has long declared that its letter-grade ratings are independent and objective, part of a bid to allay concerns over its business model [because] Standard & Poor's, like all major credit-rating firms, is paid by issuers to rate the securities that they sell…. Now, lawyers defending the company against the Justice Department's recent civil lawsuit say that statements about independence and objectivity are "puffery" and were never meant to be taken at face value by investors…. In its formal defense filed Monday, S&P pointed to two earlier court decisions where judges ruled that such statements by the firm were puffery and therefore can't form the basis for a fraud claim…. One of the decisions highlighted by S&P's lawyers is a March 2012 ruling by U.S. District Judge Sidney H. Stein. The judge dismissed a securities-fraud lawsuit filed by McGraw-Hill shareholders, who maintained that they bought shares in the company believing that S&P's ratings were independent and objective. "These statements were mere commercial puffery," and therefore can't form the basis for a fraud claim, Judge Stein wrote. That decision was upheld in December 2012 by the U.S. Second Circuit Court of Appeals, which S&P also highlighted in its Monday filing. "No reasonable purchaser of McGraw-Hill common stock would view statements such as these as meaningfully altering the mix of available information about the company," the three-judge panel wrote.

I have previously criticized judicial reliance on puffery as a safety valve to dismiss securities fraud claims.  In “Is Puffery Material to Investors? Maybe We Should Ask Them” I noted that:

Federal securities laws make it illegal to make a material misstatement in connection with a securities transaction. Materiality is generally deemed to be a fact-intensive issue only to be resolved on the basis of pretrial motions when no reasonable shareholder could find the challenged statement material. Nonetheless, and despite assertions to the contrary, materiality is often resolved pretrial. One of the doctrines relied upon by courts to dismiss securities claims on the basis of immateriality is the puffery defense. “Puffery” has been defined as ambiguous, promotional, or hyperbolic speech commonly known as “sales talk.” While the puffery doctrine has been the subject of a great deal of criticism, it continues to be relied upon by courts--in fact, its use may be increasing…. This Article seeks to fill some of the void of empirical research in this area by reporting the results of an investor survey (the “Puffery Survey”), focusing on materiality determinations in the puffery context, and comparing these responses to judicial predictions that no reasonable investor could find the surveyed statements material. What the survey results show is that while the judges in the four surveyed cases concluded that no reasonable investor could find the statements challenged therein to be material because they constituted non-actionable puffery, between 33% and 84% of reasonable investors surveyed deemed the statements material. These results have implications for both our confidence in the accuracy of judicial determinations in this area, as well as the potential utility of survey evidence for bringing judicial conclusions more in line with actual investor behavior.

In “Immaterial Lies: Condoning Deceit in the Name of Securities Regulation” I noted that:

There are a number of problems … with overdependence on materiality safety valves. First, courts' repeated declarations that management is free to lie, so long as that lie is immaterial, arguably sends the message to executives that it is often okay to embellish the truth--and sends the message to investors that they should adopt an attitude of caveat emptor (“buyer beware”) when it comes to the statements of corporate executives. One might argue that it is overly pejorative to characterize these disclosures as lies. However, when a court grounds dismissal on a finding of immateriality, it is effectively saying that there is no basis for liability even if it were proven that an executive misstated the facts with intent to deceive (i.e., there was a lie). Second, the safety valves themselves twist the definition of materiality to the point that they seemingly make a mockery of the Supreme Court's declarations on the issue. Finally, courts' excessive reliance on these safety valves creates a conflict with the disclosure rules, which often turn on determinations of materiality. Fortunately, there is a better way: focusing on the other elements of Rule 10b-5 [like scienter].

I have not yet read the opinions cited in Journal article in their entirety, but at least my initial impression is that these opinions continue a pattern of improper over-reliance on puffery as a basis for dismissing fraud claims.  In fact, to hear S&P characterize its own declarations of independence and objectivity as being nothing more than mere puffery conjures up images of the Theatre of the Absurd.